If you consider the technical analysis from the standpoint of shapes or patterns formations on the chart, it is quite difficult to bring in some kind of novelty. Over the years of observation, traders have learned to divide emerging models into reversal (i.e. signaling about the imminent trend reversal) and trend continuation patterns. But technical analysis also has patterns that, depending on the circumstances of their occurrence in the chart, may indicate both a reversal of the trend and its continuation. Today we will review one of these models. Today we will focus on “Wedge” pattern.

To avoid confusion of which wedge means what, we will analyze in stages. Two types of wedge may form on the uptrend: ascending and descending. The ascending wedge looks similar to a symmetrical triangle and is formed by the support and resistance lines that converge. Graphically, it looks like this.

This pattern on an upward chart is considered to be a reversal pattern, because after a long uptrend the buyers can no longer push the price up, so the price remains in a narrow corridor over some period of time, and after breaking through the pattern, the trend changes direction.

In contrast to the ascending wedge, the descending wedge on the uptrend shows the continuation of the trend. This wedge looks no different from the ascending, aside for its tip pointing down and being formed on the correction of the upward movement: after it’s finished, the price breaks through the wedge upwards and continues to move “north”.

Once we clarified the situation with an upward trend, let’s turn to the downward. The pattern of the same name here would also mean a possible reversal of the direction of the trend movement. At the long-term movement, the sellers will try to trade the level of the lows reached, gradually lowering them. But the strength of the trend has already dried up, and it is therefore the last success of the “bears”. After the “Wedge” pattern breaks though the resistance upwards, the trend goes in the same direction.

In contrast, the ascending wedge on a downtrend will tell the trader that we only observe the correction on the chart, and the trend will continue to move in the same direction. The apex of the triangle, consisting of support and resistance lines, looking upward, will help us to identify the ascending wedge. After breaking through the support line downwards, the descending trend will continue to get the new lows.

To sum up, we always buy at the descending wedge and always sell at the ascending, regardless of the type of trend that now prevails in the market.

TRADING RULES

Points of entry into the option to buy:

We will consider two options to buy. The first is at the formation of the descending wedge on the “bull” trend. We will follow the end of the correction and buy the Call option as soon as a rising candle closes above the resistance line. To filter the signals, we can traditionally offer to wait for closing of the next candle after breaking through the candle above the resistance.

The second option for the Call option will be a breakthrough upwards of the descending wedge on the descending “bearish” trend. After the “Wedge” pattern formation, we wait until it is broken through upwards and conclude an option to buy the asset. Also, it is wise to use filters that will protect against false alarms and unwarranted losses.

Points of entry into the option to sell:

For the sell or Put option, we will wait for the formation of the ascending “Wedge” pattern, which also can be formed on the growing or falling trend. Just as in the case of the Call option conclusion, we need to wait for the breakthrough of the wedge downwards, after which you can make a deal. To be safe from a losing deal, you can enter into contract not only after closing of the rising candle below the resistance line, but also to wait for the closing of the next candle outside the chart pattern.

SUITABLE OPTIONS

As we have already mentioned, the “Wedge” chart pattern is one of the most frequently met in the charts, and therefore this strategy generates a lot of signals. You can search for it on any charts: from a minute to a day – it all depends on the trading style you are most impressed with. If you prefer intraday trading, look for the “Wedge” on smaller timeframes and trade intraday. If you prefer medium and long-term, you should respectively explore the charts on the larger timeframes.

Today the most popular type of option that is traded under this strategy is the classic option with a fixed expiration time. However, experience shows that One Touch option also demonstrates good results with the set level of possible touch 10-15 points above or below the chart pattern. In this case, the Call or Put option can be concluded in the very moment of breakthrough of the wedge, without waiting until the candle closes outside the pattern.

EXPIRATION TIMES

The optimal expiration time for trading under the considered strategy is the length of time of the three candles after the closing of the first candle, or of two candles if the option is purchased after the closing of the second candle outside the “Wedge” pattern. That is, if we are trading on the hourly chart, the expiration time in the first case will be equal to 3 hours, in the second – 2 hours. The same rules work for trading on other timeframes.

PROFITABILITY

Despite the large number of signals generated by this trading strategy, their profitability is about 70%. That is, you can of course earn profit, but to reduce the level of false alarms, we would recommend using filters in the form of the next candle, and with the One Touch option rather than classic options, according to the rules described above.

Backtesting over the last year on two currency pairs and one raw material with the filter of the signals and the level of contact 15 points from the pattern breakthrough could increase the level of profitable signals up to 81%. That is, 4 profitable transactions accounted for one unprofitable.

MONEY MANAGEMENT

Two factors that we have already mentioned – the incidence of the signals and their low reliability – lead to the conclusion that it is unreasonable to enter the option with the risk of losing more than 2%.

If you accept the higher risk than the established, you can miss favorable signal on another instrument, because the rules of money management imply that the risk of all the transactions shall not exceed 5% of the deposit amount. Choosing a risk equal to 2%, you retain the right for an additional entry into the market following another signal or on another asset.

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